The present invention generally relates to a method and system for promoting sulfur dioxide futures trading.
The world's environment faces significant threats from anthropogenic or “human-caused” releases of greenhouse gases to the atmosphere. Greenhouse gases, such as water vapor, carbon dioxide, tropospheric ozone, nitrous oxide, and methane, are generally transparent to solar radiation but opaque to longwave radiation, thus preventing longwave radiation energy from leaving the atmosphere. The net effect of greenhouse gases in the atmosphere is a trapping of absorbed radiation and a tendency to warm the planet's surface.
Greenhouse gases can be released, for example, by the release of carbon dioxide during fossil fuel combustion. Thus, automobiles, factories, and other devices that combust fuel release carbon dioxide gases into the atmosphere. However, greenhouse gases can also be released by more natural means. For example, farmers may till farmland such that carbon dioxide from the tilled ground is released into the air. The removal of forest stands, or deforestation, can also result in the release of greenhouse gases.
The rapid increase in the concentration of greenhouse gases in the earth's atmosphere caused by human activity increases the risk of fundamental and costly changes in the earth's climate system. For example, the changes may include more severe drought/precipitation cycles, longer and more extreme heat waves, the spread of tropical diseases, damage to vegetation and agricultural systems, and threats to coastlines and property due to higher sea levels and storm surges.
In the 1980's, the United States implemented an emissions trading system to phase out lead from motor fuel. This effort was followed by a highly successful U.S. Environmental Protection Agency (EPA) sulfur dioxide (SO2) emissions trading program. To reduce acid rain, an overall cap on SO2 emissions was imposed on electric power plants. Utilities that found it expensive to cut sulfur emissions could buy allowances from utilities that make extraordinary cuts at low cost.
Tradeable SO2 allowances are an integral element of the United States Clean Air Act (as amended in 1990) program that requires a major reduction in emissions released by electric power plants. Tradeable emission allowances are issued by the U.S. Environmental Protection Agency (EPA) to each fossil-fueled electric power plant in an amount corresponding to each plant's nominal emission limit. The total quantity of issued allowances corresponds to the national emission limit. Each spring every power plant must relinquish to the EPA a quantity of allowances that equals the prior-year emissions total (as quantified using required emission monitors). Those entities that reduce emissions below their allowance allocation are free to bank (for future use), or sell, their excess allowances. Plants that do not reduce emissions to the allowance allocation level must acquire allowances in order to achieve compliance. The market in tradeable SO2 allowances has grown to a transaction value in excess of $4 billion per year. In the past year, prices have risen rapidly (from $200 to over $600 per ton) and have become very volatile. These developments have enhanced the need for a financially guaranteed and standardized instrument for use in price hedging and trading.
Each issued emission allowance (which exists as a serial number in the EPA's registry, called the “Allowance Tracking System”) has a “vintage” assigned to it as part of its serial number. The EPA issues in advance a thirty-year stream of allowances. The vintage designates the first year the allowances can be used in compliance. For example, the first year allowances with a 2004 vintage can be relinquished to the EPA to meet emission limits is the 2004 compliance year, for which compliance is documented (“true-up”) in early 2005. While an unused 2004 allowance is automatically “banked” (held in its owner's account) and can be used to meet emission limitation commitments for later years, a 2005 vintage allowance cannot be used in compliance to meet emission limits for years before 2005. That is, one cannot “borrow” from the future to meet current emission limits.
One implication of allowance vintages is that there are different market prices for different allowance vintages. The “spot” market involves trading in allowances usable in compliance to meet calendar year 2004 emission limits. Because banking is allowed, trading in 2004 vintage allowances is understood by market participants to include all allowances having a 2004 vintage, as well as all banked allowances having a vintage earlier than 2004. Consequently, market participants treat each allowance vintage later than 2004 as a distinct market. As a result, 2005 vintage allowances trade at prices slightly different from 2004 vintage allowances, and also trade at prices that are different from those of 2006 and 2007 allowances.
The art of designing successful futures contracts, defined as futures contracts that attract significant participation which facilitate low-cost execution of trades, requires the establishment of terms that provide market opportunities for a variety of entities. The contract specifications must serve the interests of hedgers (those who use the contracts to manage their existing exposure to adverse price changes in the underlying commodity) and traders, including speculators, who provide market liquidity trading with the goal of profiting from price changes.
Futures contracts are used by hedgers primarily for the purpose of protecting against economic loss due to adverse price changes in the underlying commodity. The great majority of futures contract positions (buy-side “long” positions and sell-side “short” positions) are netted out before the contract reaches its denoted expiration date. This netting occurs through the initiation of a position that is opposite the one the account holder held as expiration approaches. A holder of a long position will sell to get “flat” (out of the market), and the holder of a short position will buy to get “flat.” Position holders that do not net out a long or short position before the futures contract expires become part of the delivery process. Those who stay “short” must deliver eligible instruments and those who remain “long” will be required to make payment and accept delivery.
A need therefore exists for an improved method and system that will promote successful SO2 futures trading.